Economy and capital markets

The last week has been startling for many investors. Volatility – specifically, downside volatility – has re-emerged in a big way. After Monday’s largest one-day point drop ever (more on that later) in the Dow Jones Industrial Average (the Dow) and the S&P 500, stocks are now slightly in negative territory for the year. After nine consecutive calendar years of positive returns from stocks, this feels unnerving.

Returns data through February 5, 2018 (Morningstar):

Market Index

Asset Type

Year-to-Date Total Return Percentage

Dow Jones Industrial Average

Large Cap Stocks

-1.42

S&P 500

Large Cap Stocks

-0.80

Russell 2000

Small Cap Stocks

0.82

MSCI EAFE

International Stocks

1.84

MSCI EM

Emerging Markets Stocks

4.45

Regarding the year-to-date returns above, we would note that, although they have sold off in sympathy with U.S. markets, international and emerging markets stocks are positive for the year. Investment-grade bonds (as measured by the Bloomberg Barclays U.S. Aggregate Index) are slightly negative year-to-date at -1.5 percent, but posted a positive return during Monday’s drop in stock prices. Diversification remains important.

What’s been rattling the markets?

One factor is renewed concern about higher inflation and interest rates. The latest U.S. jobs report last Friday showed an uptick in wages, which is viewed as a signal of higher inflation. Meanwhile, the U.S. 10-year Treasury note yield nearly hit 2.9 percent over the last week, up substantively from a year ago. (The 10-year note stands at 2.75 percent as of this writing.)

We and other analysts have written about how the stock market had been remarkably calm over the past year. There are many statistics that highlight just how unusually smooth the ride has been for U.S. stocks, but here is just one example: Until this past week, we had gone more than 400 trading days without a 5 percent pullback, the longest in history. No one could have predicted when, but getting this 5+ percent pullback was inevitable.

Percentage loss, not points, is a better measure

February 5, 2018, was an ugly day in the stock market, to be sure. But the financial press sometimes can be guilty of stoking the flames of fear. For example, Monday’s market action could have resulted in using either of the following two headlines, both of which are true:

Headline A: The Dow and S&P 500 Suffer Largest Point Drops in History

Headline B: S&P 500 Suffers 138th Largest Percentage Drop in History*

You may have noticed a lot of press that read or sounded like Headline A, but very few like Headline B.

It’s important to keep things in perspective. Yes, the Dow losing 1,175 points on February 5 is distressing, but the magnitude of declines are better viewed as percentages. One example: On October 19, 1987, the Dow fell 507 points ― which equated to an astounding loss of nearly 23 percent. Monday’s negative 4 percent move pales in comparison and doesn’t come close to registering near the top of lists of biggest one-day sell-offs.

We urge investors to stay the course

The U.S. and global economies appear strong and show scant evidence of a forthcoming recession. We observe a global expansion at this time, with very high levels of small business confidence and consumer confidence.

Furthermore, corporate earnings are strong and the new tax law should further benefit corporate earnings going forward. The declines in stock prices over the last week are not a good reason to abandon a thoughtfully planned and well-diversified asset allocation strategy based on your personal financial plan. Although the volatility of recent days can be worrisome, when viewed from a long-term perspective, such events are normal and expected.

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